Target Retirement Date ETFs: 3 Things To Consider

Exchange-traded funds have made it easy for individual investors to affordably invest in nearly anything. From hard commodity ETFs to international equity ETFs, individual investors have access to corners of the market that were previously accessible to only institutions. But, ETFs have also made it easy to invest in a targeted portfolio of common stocks and bonds by purchasing just a single security. These so-called “total portfolio” ETFs represent a new paradigm that is perfect for many individual investors looking to avoid money managers [see this interactive guide to Finding The Right Target Retirement Date ETF For You].

What’s the Appeal?

Target Retirement Date ETFs are “total portfolio” funds designed for retirement investors seeking an easy alternative to creating their own portfolio or using money managers. By investing in a single security, investors can gain exposure to a diverse portfolio of stocks and bonds that is customized to suit their investment objectives with ideal asset allocations; however, there are also many disadvantages that investors should carefully consider before buying.

Some advantages include:

Single Security – Investors can purchase a single security that contains an inherently diversified and targeted portfolio of stocks and bonds. For example, the iShares Target Date ETFs contains exposure to around 6,000 different securities.

Asset Allocation – Target Retirement ETFs are especially designed to maintain an asset allocation that’s ideal for investors retiring in a given year. For instance, those closer to retirement will be weighted more towards bonds than equities.

Low Maintenance – Since rebalancing is done automatically, Target Retirement ETFs require very little maintenance, unlike maintaining a portfolio of stocks that may need to be refined every year or two based on changes in weight or mix.

Some disadvantages include:

Double Costs – Target Retirement ETFs charge management fees, while the funds that they hold may charge their own management fees, too. For example, the iShares Target Date ETFs have management fees of 0.25% plus 0.21% in acquired fund fees and expenses, although there’s a fee waiver that results in a 0.32% net expense.

Suitability – Target Retirement ETFs make broad assumptions based on a targeted retirement date, which means they may not be suitable for everyone. For example, a wealthier investor may want to take greater risks than a non-wealthy investor [see Aggressive Portfolio].

What’s Really in My Target Retirement Portfolio?

Target Retirement Date ETFs focus on maintaining asset allocations consistent with a target retirement date. Moreover, these ETFs tend to hold other funds or ETFs rather than individual stocks or bonds, making them “funds of funds” that may incur double costs. For example, a 2018 Target Retirement ETF will likely be holding a variety of bond-related funds in 2013, since investors holding the ETF are looking to retire in just five years [see Visualizing Target Retirement Date ETFs].

Let’s take a look at two specific examples with different target dates:

iShares Target Date 2020 ETF (TZG, A-) – This ETF holds 42% domestic fixed income and 39% domestic equity, with approximately seven years until expiration. While it has an expense ratio of 0.25%, many of its holdings have their own expense ratios being ETFs themselves. These holdings include names like the iShares Core Total U.S. Bond Market Fund and the iShares Core S&P 500 Fund, which both have a ~27% weighting and, in aggregate, tack on 0.21% in “acquired fund fees and expenses.”

iShares Target Date 2045 ETF (TZW, B) – This ETF holds 58% domestic equity, 27% international equity, and 14% domestic fixed income, with approximately 32 years until expiration. With an expense ratio of 0.25%, many of the fund’s holdings also have their own expense ratios, which add on 0.21% in “acquired fund fees and expenses.” These holdings also include names like the iShares Core S&P 500 ETF (39.5%), iShares MSCI EAFE Index Fund (22.81%) and other equity funds.

Target Retirement Date ETFs Do Deliver Attractive Returns

There is a common misconception that Target Retirement Date ETFs do not deliver attractive returns – possibly because the term “retirement” carries risk-averse connotations. But performance is largely variable, with equity-heavy, long-dated Target Retirement Date ETFs having outperformed since the global recovery, and bond-heavy near-term Target Retirement Date ETFs outperformed during the crisis in terms of risk-adjusted returns [see The Cheapest ETF for Every Investment Objective].

Here are some of the Target Retirement ETFs that have outperformed recently:

The Bottom Line

Target Retirement Date ETFs represent a great way for investors to quickly and easily invest in an ideal mix of funds given a certain retirement date. While these funds involve greater fees than many others, their asset allocations are automatically adjusted over time and they involve very little effort on the part of the individual investor utilizing them. Some of these funds even outperform broad market indexes on a consistent basis.

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